Spotlight on Asset Based Finance Loans

Traditional bank loans are granted to a business based on its creditworthiness as reflected in its financial statements and certain financial ratios.

What many small business owners don’t know is that, even if financial statements and ratios are nowhere near qualifying for a traditional loan, a business may be able to secure an asset based finance loan if it has valuable accounts receivables and/or inventory.  Banks and commercial finance companies are willing to extend credit to a business secured by the business’s accounts receivables and/or inventory.

Of course, a business with accounts receivables worth $1 million will not be able to borrow $1 million against such receivables.   Banks and commercial finance companies have detailed rules and procedures on what qualifies as an “eligible receivable” and how much can be borrowed against such eligible receivable (so called “advance rate”).   Without regard to how much the lender lends against the receivables, the lender will take a security interest in the entire pool of receivables owned by the business.

Because repayment depends on the accounts receivables and inventory, banks or commercial finance companies that grant an asset based finance loan will closely analyze the accounts receivables and inventory and, after the loan has been granted, monitor such assets.  Thus, expect the loan administration for an asset based finance loan to be more involved and burdensome than in a traditional financial statement loan.

An asset based loan typically requires the business to open a dedicated bank account (“cash collateral account”) into which all collections on receivables must be deposited and subsequently applied to the repayment of the loan.

Most asset based finance loans do not require that the debtors on the accounts receivables be notified.  Only the business and the lender will know that the accounts receivables are pledged as security for an asset based loan. 

Documentation of an asset based finance loan typically includes:

a Credit Agreement

setting forth the main terms of the loan, such as the amount of the loan or credit line, interest rate, repayment terms, which receivables and inventory qualify as eligible receivables or eligible inventory, and the advance rate;

a Security Agreement

creating a security interest in all accounts receivables and inventory of the borrower;

a Promissory Note

containing a promise to repay the loan;

UCC Filings

documenting the priority of the lenders security interest in the receivables and inventory as against later security interests;

Borrowing Resolutions

the business’s authorization of the loan transaction;

Personal Guarantee

by the owner(s) of the company.

I know that many small businesses try to negotiate and close even larger asset based loans on their own, not realizing that all terms of an asset based loan are negotiable and that the loan terms can have a major impact on the business.

Don’t be sorry later.  Make an experienced attorney part of your financing strategy.  Ideally, choose an attorney who does not regularly represent banks and commercial finance companies in asset based loan transactions.  How hard is that attorney going to negotiate on your behalf when he or she knows that his or her  bank and commercial finance company clients would like to have small businesses believe that certain terms are “industry standard" and not negotiable.

Where can you find asset based finance lenders?  Ask your bank, accountant or lawyer for a referral.  In addition, you may want to check out the website of the Commercial Finance Association which includes a section called “find financing.”

About Imke Ratschko

Imke Ratschko is a New York Attorney helping small businesses, business owners and entrepreneurs with all things "Small Business Law," such as litigation, contracts, business owner disputes, shareholder and operating agreements, sale or purchase of a business, investors, and starting a business. You can reach her at 212.253.1027.


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